Classification of Economic Conditions 1

Prosperity Employment rate and demand for products and services are high. Recession Unemployment rate is increasing and demand for products and services are lowering. Depression Unemployment rate is high and demand for products and services is lowering. Recovery Unemployment rate is lowering and demand for products and services is increasing. 2

Year123 Income Income percent change from year 1 $36,000n/a$38,0005.6%$21,000-42% Gallon of milk cost Gallon of milk cost percent change from year 1 $2.49n/a$2.9920%$3.1928% Over a three-year period, how has the income been impacted by the cost of a gallon of milk? 3

Consumer Prices Inflation Inflation Causes of inflation Causes of inflation Consumer Price Index (CPI) Consumer Price Index (CPI) Deflation Deflation Causes of deflation Causes of deflation 4

Measuring Economic Activity Inflation. Inflation. The rapid rise in prices caused by an inadequate supply of goods and services. The rapid rise in prices caused by an inadequate supply of goods and services. Total demand exceeds total supply. Total demand exceeds total supply. Dollars are plentiful, so their value declines and prices increase Dollars are plentiful, so their value declines and prices increase The result is a decline in purchasing power; A dollar does not buy as much as it did before inflation. The result is a decline in purchasing power; A dollar does not buy as much as it did before inflation. Retirees and individuals on a fixed income are financially hurt the most because their income buys less. Retirees and individuals on a fixed income are financially hurt the most because their income buys less.

Benefits of Inflation Economists suggest that an inflation rate of 2-3% is healthy for the economy. Economists suggest that an inflation rate of 2-3% is healthy for the economy. Wages rise more slowly than prices. Wages rise more slowly than prices. Producers make more profit and can hire more workers. Producers make more profit and can hire more workers. Unemployment is lower. Unemployment is lower. Newly employed workers spend more money and stimulate the economy. Newly employed workers spend more money and stimulate the economy. The United States usually has mild to moderate inflation. The United States usually has mild to moderate inflation.

Disadvantages of Inflation If you do not keep up with inflation, consumers will have a lower standard of living. If you do not keep up with inflation, consumers will have a lower standard of living. Inflation most affects people on a fixed income, retirees and the unemployed. Inflation most affects people on a fixed income, retirees and the unemployed. Most workers are affected when inflation is at a moderate level. Most workers are affected when inflation is at a moderate level.

Disadvantages of Inflation Increasing inflation reduces the consumers' ability to buy goods and services. Increasing inflation reduces the consumers' ability to buy goods and services. Money does not buy as much (the value of the dollar goes down). Money does not buy as much (the value of the dollar goes down). Consumers will purchase only necessary goods. Consumers will purchase only necessary goods. Consumers will have to cut back on their spending Consumers will have to cut back on their spending

Disadvantages of Inflation Inflation occurs when there is too much money in the economy. Inflation occurs when there is too much money in the economy. The government raises interest rates to take money out of the economy. The government raises interest rates to take money out of the economy. Rising interest rates discourage consumers and businesses from borrowing money. Rising interest rates discourage consumers and businesses from borrowing money. Sales of durable goods fall. Sales of durable goods fall. Consumers "make do" with current homes, cars, etc. Consumers "make do" with current homes, cars, etc. Business owners do not borrow to expand. Business owners do not borrow to expand.

Disadvantages of Inflation Workers ask for higher wages; businesses raise prices to pay for the increases. Workers ask for higher wages; businesses raise prices to pay for the increases. As consumers stop spending, business sales fall and owners must cut back. As consumers stop spending, business sales fall and owners must cut back. Some businesses have to layoff workers Some businesses have to layoff workers People who lose their jobs will be able to buy fewer goods and services People who lose their jobs will be able to buy fewer goods and services Careful financial management is crucial in dealing with inflation. Careful financial management is crucial in dealing with inflation.

Disadvantages of Inflation Careful budgeting helps consumers cope with limited economic resources. Careful budgeting helps consumers cope with limited economic resources. Wise decision-making is also necessary to combat the effects of inflation. Wise decision-making is also necessary to combat the effects of inflation. Comparison shopping, not impulse buying. Comparison shopping, not impulse buying. Change lifestyle as needed. Change lifestyle as needed. Savings and investments must keep up with or ahead of inflation so that the money saved does not lose value. Savings and investments must keep up with or ahead of inflation so that the money saved does not lose value.

Measuring Economic Activity Consumer Price Index (CPI). Consumer Price Index (CPI). A measure of the average change over time in the prices paid by urban consumers for a market basket of 400 consumer goods and services: A measure of the average change over time in the prices paid by urban consumers for a market basket of 400 consumer goods and services: Food and beverage. Food and beverage. Housing. Housing. Apparel. Apparel. Transportation. Transportation. Medical Care. Medical Care. Education. Education.

Measuring Economic Activity Deflation: Deflation: A decrease in the volume, or amount, of currency so that there is less currency available for goods and services within a free market; this tends to force market prices lower. A decrease in the volume, or amount, of currency so that there is less currency available for goods and services within a free market; this tends to force market prices lower. Deflation occurs when too few dollars are chasing too many goods. Scarce dollars are worth more, so prices go down. Deflation occurs when too few dollars are chasing too many goods. Scarce dollars are worth more, so prices go down.

Interest Rates Types: Types: Prime rate Prime rate Discount rate Discount rate T-bill rate T-bill rate Treasury bond rate Treasury bond rate Mortgage rate Mortgage rate Corporate bond rate Corporate bond rate Certificate of deposit rate Certificate of deposit rate What is the primary purpose of each? How do interest rates impact businesses? 15

Prime Rate The interest rate charged by banks to their most creditworthy customers (usually the most prominent and stable business customers). The interest rate charged by banks to their most creditworthy customers (usually the most prominent and stable business customers). The rate is almost always the same amongst major banks. The rate is almost always the same amongst major banks. Adjustments to the prime rate are made by banks at the same time Adjustments to the prime rate are made by banks at the same time The prime rate does not adjust on any regular basis. The prime rate does not adjust on any regular basis. The Prime Rate is usually adjusted at the same time and in correlation to the adjustments of the Fed Funds Rate. The Prime Rate is usually adjusted at the same time and in correlation to the adjustments of the Fed Funds Rate.

Discount Rate The interest rate charged to commercial banks and other depository institutions The interest rate charged to commercial banks and other depository institutions On loans they receive from their regional Federal Reserve Bank's lending facility On loans they receive from their regional Federal Reserve Bank's lending facility Under the primary credit program, loans are extended for a very short term (usually overnight) Under the primary credit program, loans are extended for a very short term (usually overnight)

T-bill Rate A short-term debt obligation backed by the U.S. government A short-term debt obligation backed by the U.S. government Maturity of less than one year Maturity of less than one year Sold in denominations of $1,000 Sold in denominations of $1,000 Maximum purchase of $5 million Maximum purchase of $5 million Commonly have maturities of one month (four weeks), three months (13 weeks) or six months (26 weeks). Commonly have maturities of one month (four weeks), three months (13 weeks) or six months (26 weeks).

Treasury Bond (T-Bond) Rate A marketable, fixed-interest U.S. government debt security A marketable, fixed-interest U.S. government debt security Maturity of more than 10 years Maturity of more than 10 years Make interest payments semi-annually Make interest payments semi-annually The income that holders receive is only taxed at the federal level The income that holders receive is only taxed at the federal level

Treasury Bond (T-Bond) Rate Issued with a minimum denomination of $1,000 Issued with a minimum denomination of $1,000 Sold through auction Sold through auction

Mortgage rate Interest rate on a loan secured by a mortgage on a property Interest rate on a loan secured by a mortgage on a property A Mortgage is a debt instrument that is secured by the collateral of specified real estate property A Mortgage is a debt instrument that is secured by the collateral of specified real estate property Borrower is obliged to pay back with a predetermined set of payments Borrower is obliged to pay back with a predetermined set of payments

Corporate Bond Rate A debt security issued by a corporation and sold to investors A debt security issued by a corporation and sold to investors The backing for the bond is usually the payment ability of the company The backing for the bond is usually the payment ability of the company typically money to be earned from future operations typically money to be earned from future operations Considered higher risk than government bonds Considered higher risk than government bonds

Corporate Bond Rate Interest rates are almost always higher, even for top-flight credit quality companies. Interest rates are almost always higher, even for top-flight credit quality companies. Issued in blocks of $1,000 in par value Issued in blocks of $1,000 in par value A major source of capital for many businesses A major source of capital for many businesses

Certificate of Deposit Rate A savings certificate entitling the bearer to receive interest. A savings certificate entitling the bearer to receive interest. Bears a maturity date Bears a maturity date A specified fixed interest rate A specified fixed interest rate Can be issued in any denomination Can be issued in any denomination Generally issued by commercial banks Generally issued by commercial banks Insured by the FDIC Insured by the FDIC Ranges from one month to five years. Ranges from one month to five years.

Certificate of Deposit Rate It is a time deposit that restricts holders from withdrawing funds on demand. It is a time deposit that restricts holders from withdrawing funds on demand. It is still possible to withdraw the money, this action will often incur a penalty. It is still possible to withdraw the money, this action will often incur a penalty.